Investing 101 – Understanding How to Invest in Stocks

Stocks and bonds offer a way for anyone to invest their money. They are difficult to analyze but the concepts are easy to understand. Do you know how to invest in stocks? Investing in stocks isn’t as hard as you think it is. Here’s what you need to know about going long in stocks. For those who might not already know, we will take a minute to discuss these two options.

A stock is an equity in a company. If the company gains in value, your piece of ownership increases in value and you earn money. Conversely, if the company lowers in value, you then lose money.

A bond is a debt that a company borrows. Essentially, if you buy a bond, it is giving the company a loan. In other words, it’s an I-O-U. This loan is repaid over time with interest.

Long positions are what the average person invests in. This is betting on the fact that a company will increase in value. On the other end of the spectrum is a short position. Short positions, also called short selling, is a way to bet against a stock.

Now that you understand a bit about investing, let’s take a look at how long and short positions work in stock trading.

Long Position Stocks

The old adage “buy low, sell high” comes from taking a long position in a stock. We will use a fictional company called COM for this example.

COM is currently valued at $50 per share. You have $10,000 to invest. You decide to put all of it in COM, thus receiving back 200 shares.

After a few months, COM sells a patent to Apple for a large sum of money. This causes the value of COM’s stocks to skyrocket to $80 per share. You decide that the increase is enough for you to sell off your shares. Since you bought the shares at $50 and you sell all 200 shares at $80, you have earned $6,000 in just a few months time.

Short Positions Stocks

Short positions are the opposite of long positions. A company is expected to go down in value and while many people will lose money, you plan to make money. To better understand how to short a stock, we will use a fictional scenario.

Consider that you are interested in shorting a stock. For this example, we will use a fictional company called FIC. You feel the value of FIC is higher than what it should be and that the market will soon react accordingly and the stock price will lower.

FIC is currently priced at $20 a share. You believe that it will go down to as low as $16 per share by the end of the week. In order to bet against the value, you would place a “sell short” order for the amount of share you would like to risk. In this case, you decide to sell short 100 shares at $20 per share.

At the end of the week, FIC has dropped to $16 as you predicted. Now you do what is called “covering”. This means that you are selling the shares that you originally borrowed from your lender at $20. Since there is a $4 difference in stock price from the time you borrowed and you have 100 shares shorted, you have earned $400 (minus any fees and commissions).

Final Thoughts

Just as with many things in life, investing is not a guarantee. They say that you should never invest money that you are not willing to lose. On the other hand, there is no better way to earn a passive income. For more information, check out other articles on our site.